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Federal vs. Private Student Loans Comprehensive Guide

What to Expect From This Guide

In this guide, we’re going to consider the differences between federal vs. private student loans. However, since we have covered private student loans extensively in another guide in this guide we will focus primarily on federal student loans. This will include the various types of federal student loans, including terms and rates, as well as how to apply. We will also spend time discussing both the advantages and disadvantages of federal student loans in relation to private student loans.

Specifically, we will cover the following topics:

What are Federal Student Loans?

What are Private Student Loans?

The Best Features of Federal Student Loans

The Best Features of Private Student Loans

Federal vs. Private Student Loan Side-by-side Comparison

When are Federal Student Loans the Best Choice?

When are Private Student Loans the Best Choice?

What are Federal Student Loans?

Just as the name implies, federal student loans are higher education loans provided by the U.S. Department of Education (US DOE), an agency of the federal government. They can be obtained either directly from the US DOE, or through a bank or credit union, or even directly through the college you are attending.

There are actually two primary broad loan types: the William D. Ford Federal Direct Loan, referred to simply as the “Direct Loan”, and the Federal Perkins Loan.

The Direct Loan is made directly by the federal government, and is sometimes referred to as a Stafford Loan. It is the largest federal student loan program, and it comes in four variations:

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1. Direct Subsidized Loans. These loans are for undergraduate students who have a demonstrated financial need. (Demonstrated financial need is defined as the difference between the cost of attendance, or COA, at a college and your Expected Family Contribution, or EFC.) The US DOE pays the interest on the loan while you are enrolled in school, during the six month grace period after graduation, and during any additional deferments of your monthly payments.

2. Direct Unsubsidized Loans. These are loans for undergraduate students who do not have a demonstrated financial need. Students can be enrolled in undergraduate, graduate or professional level programs. You are responsible to pay interest on the loan during all phases, including school attendance, the grace period and forbearance. If you don’t make interest payments during those times, the amount of the unpaid interest will be added to your loan balance, increasing the amount of principal due.

Under both the Subsidized and Unsubsidized variations, you can borrow from between $5,500 and $12,500 per year – up to a maximum lifetime limit of $31,000 – as an undergraduate student, or up to $20,500 per year as a graduate student under the Unsubsidized program. The school you’re attending determines the specific amount you can borrow within those limits. No credit check is required under either loan type.

3. Direct PLUS Loans. These loans are available for either parents of undergraduates, or for students enrolled in graduate or professional programs. PLUS can be used to finance costs not covered by Subsidized or Unsubsidized loans. Credit qualification is required on PLUS loans. NOTE: As a parent borrower, you cannot be released of liability on a Direct PLUS Loan until it is fully paid.

Interest rates and Fees on Direct Loans. Interest rates for both Subsidized and Unsubsidized loans for undergraduates are currently set at 3.76% APR. For graduate students, the interest rate is 5.31% APR for Unsubsidized loans. With both Subsidized and Unsubsidized loans there is an origination fee of 1.069% of the amount borrowed. For Direct PLUS loans the interest rate is 6.31% APR, and the origination fee is 4.276% of the amount borrowed. All loan types are fixed rates for terms of between 10 and 25 years.

4. Direct Consolidation Loans. These loans enable you to consolidate several federal student loans into a single loan with one loan servicer. The loan is available once the student completes his or her education (or otherwise leaves school), and can be obtained for a term of 10 to 30 years. There is no specific interest rate on Consolidation loans. Your rate is a weighted average of the existing student loans being consolidated. As such a consolidation will not lower your effective interest rate, but it will result in a single monthly payment, which may be reduced if the term of the consolidation is longer than the loans contained within it.

The Federal Perkins Loan

These loans are provided by the school, though not all colleges participate in the program. They are available for both undergraduate and graduate students who have exceptional financial need. Funds for the program are limited so not everyone who applies for a Perkins loan will actually get it.

Undergraduates can receive up to $5,500 per year, to a total lifetime limit of $27,500, while graduate students can borrow up to $8,000 per year, to a maximum lifetime limit of $60,000 (including funds borrowed as an undergraduate).

The interest rate on the Perkins loan is 5.00% APR and there are no origination fees or application fees. There is a nine month grace period after graduation after which you must begin making repayment.

Applying for a Federal Student Loan

In order to apply for a federal student loan you will have to complete a Free Application for Federal Student Aid (FAFSA). You can do this online at the FAFSA website, or through the college you will be attending. The application is 10 pages long, but it will open the door not only to student loan options, but also to any financial aid opportunities that may be available for you.

What are Private Student Loans?

Private student loans perform much the same function as federal student loans. They provide loans for both undergraduate and graduate education, as well as the potential to do either refinances or consolidations of your existing student loans.

There are some significant differences. For example, private student loans require that you credit qualify. That means you must demonstrate that you are able to carry the loan payments based on your credit history and your income. If you cannot qualify based on your own financial resources, because you are a student, you can generally add a qualified cosigner to your loan in order to qualify.

Like federal student loans, private student loans also do provide for partial or full deferral of your loan payments at certain times during the loan process. This includes the time while you are in school, a grace period after graduation, and forbearance under certain limited circumstances.

For example, while in school, they may offer a full deferral of your payments. They may also limit your payments to interest only, that way you can at least avoid adding interest to the principal balance of your loan. Finally, some private student loan lenders do require that you make a small monthly payment, such as $25 per month. The basic idea is to minimize the amount of money that you will owe by the time you graduate. And they will naturally encourage you to make larger than the minimum payments in order to lower the debt obligation even more.

Private student loans don’t offer IBR and PSLF arrangements in the event that you need to either lower your monthly payment or seek debt forgiveness (see below), but they often do provide some form of forbearance in the event that you are having difficulty making your payments.

For example, they may attempt to either help you with a refinance that will provide lower monthly payments, or they may suspend your monthly payments for a certain period of time until you are back on your feet. In the event that you are unemployed, they may suspend the monthly payments until you are reemployed. Generally, if they provide this option, they will also offer job placement assistance, which you must participate in, in order to continue the forbearance. The length of the forbearance will vary with each lender as well as the personal circumstances surrounding the financial difficulty.

The Best Features of Federal Student Loans

Below are the basic advantages that federal student loans have over private student loans.

Low interest rates. Rates as low as 3.76% are lower than fixed rates offered by most private student loan lenders.

Longer loan terms. While private student loans typically limit your loan term to 15 years, federal student loans can be as long as 25 years, and even up to 30 years on the Direct Consolidation loan. The longer term means that monthly payments are lower and more manageable.

Fixed rates. The lowest rates on private student loans are on variable rate loans. But these can rise substantially – up to 18%. Federal student loans are fixed rates, which means your payment and rate will always be stable.

Subsidized interest rates on certain loans. On Direct Subsidized Loans the US DOE pays the interest on your loan while you’re in school, in the grace period or in deferment.

No credit qualifying. Except for the PLUS loan, you don’t need to have acceptable credit or income in order to get a federal student loan. Private student loans always require credit qualifying, which as a student you probably won’t have.

Payments not required while you’re in school. Many private lenders do require monthly payments even while you’re in school. Federal student loans don’t.

Cosigners not required. With most federal student loans you won’t need to have a co-signer. With private student loans this is a common requirement.

Inability to pay. If you can’t pay your loan, federal student loans provide two programs that can provide relief. The Income-Based Repayment Plan (IBR) limits your monthly payment to 10% of your discretionary income. Meanwhile, the Public Service Loan Forgiveness Program (PSLF) offers the opportunity to have your remaining loan balance forgiven on your Direct Loans after you have made 120 qualifying monthly payments under a qualifying repayment plan while working full-time for a qualifying employer, which is usually a government agency.

The Best Features of Private Student Loans

Despite the long list of features that favor federal student loans, private student loans have some definite advantages.

No origination fees. Federal student loans come with origination fees equal to 1.069% to 4.276% of the amount borrowed. In most cases, private student loans do not require the payment of origination fees. This can result in the saving of several thousand dollars. It’s also worth noting that the origination fees are typically added to the loan balance, which means that you’ll then pay interest on the amount of the fees. This can increase the cost even more, particularly if the loan term runs for 25-30 years.

Larger loan amounts. While federal student loans typically don’t require that students credit qualify, the amounts you can borrow are limited. Private student loans have much more generous loan limits, going well into the hundreds of thousands of dollars. If you can qualify to do so, you can borrow enough to cover your entire college costs using private student loans.

Cosigner release. If you have a cosigner on a federal student loan, that person will remain on the loan until it’s fully paid. That’s a long time if it’s a 30 year loan. Most private student loans do provide for a cosigner release. A typical requirement is that the monthly payments must have been made on time for anywhere from 24 to 48 months, and if you can demonstrate that you can qualify to cover the loan based on your income and credit history. Since this is most likely to happen after you have graduated from college and have already entered a career, you will be in position to assume sole responsibility for the loan in a way you never could as a student.

Federal student loans cannot be discharged in bankruptcy. This is one of the major negatives commonly associated with federal student loans. No matter how bad your financial situation may be, federal student loans cannot be discharged in bankruptcy. This is not the case when it comes to private student loans. This is not a recommendation that you take private student loans so that you can default on them in bankruptcy after the fact, but rather a recognition that you retain an important credit option in the event that you face legitimate financial difficulties in life.

CATEGORY / LOAN TYPE

FEDERAL STUDENT LOANS

PRIVATE STUDENT LOANS

Credit qualification required

No

Yes

Maximum loan amount

$5,500 to $20,500

No specific limit

Payment deferrals while in school

Yes

Yes, but some payment arrangement is encouraged

Interest rate assistance

Yes, on some loans

No

Interest rate range

3.76% APR to 6.31% APR

2.25% APR to 12.99% APR

Fixed or variable?

Fixed only

Fixed or variable

Loan term

10 to 30 years

5 to 15 years

Origination fees

1.069% to 4.276%

Generally none

Cosigner allowed

Yes

Yes

Cosigner release

No

Yes, if payments made on time 24 - 48 months, plus demonstration of ability to qualify without cosigner

Payment relief

Yes, Income Based Repayment plan (IBR)

None

Loan forgiveness

Yes, Public Service Loan Forgiveness Program (PSLF)

None

Hardship forbearance

Yes

Generally yes, but how much depends on the lender

Dischargeable in bankruptcy

No

Yes

When are Federal Student Loans the Best Choice?

Since they don’t require that you be credit qualified in order to get a loan, federal student loans are typically the better choice when you’re actually a student. The loan amounts may not be as generous as they are with private student loans, but they are easier to qualify for which may be what you most need while you are a student.

Federal student loans also do not require that you make monthly payments while you are in school. In addition, under certain programs, the US DOE will make the interest payments for you, so that not only do you not have to make payments, but the interest is not added to your loan principal upon graduation.

When are Private Student Loans the Best Choice?

Private student loans can be the better option if you are able to qualify on your own credit and income, or if you have a strong co-borrower who can qualify for the loan. They also have the advantage of more generous loan amounts. If you plan to finance more of your education costs, private student loans could be the better loan type.

Private student loans also offer more options in the event of a refinance. Many will enable you to refinance any amounts that were used in order to pay for your education. Federal student loans, by contrast, will generally allow you only to refinance other federal student loans, and not private student loan amounts.

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